Abc Company Sells A Wide Range Of Drums Bins Boxes And Other Containers That Are Use 2875765

ABC Company sells a wide range of drums, bins, boxes, and other containers that are used in the chemical industry. One of the company’s products is a heavy-duty corrosion-resistant metal drum used to store toxic wastes. Production is constrained by the capacity of an automated welding machine that is used to make precision welds. A total of 2,000 hours of welding time are available annually on the machine. Because each drum requires 0.8 hours of welding time, annual production is limited to 2,500 drums. At present, the welding machine is used exclusively to make the drums. The accounting department has provided the following financial data concerning the drums:Management believes 3,000 drums could be sold each year if the company had sufficient manufacturing capacity. As an alternative to adding another welding machine, management has looked into the possibility of buying additional drums from an outside supplier. Metal Company, a supplier of quality products, would be able to provide up to 1,800 drums per year at a price ofDrums$120 per drum, which ABC Company would resell to its customers at its normal selling price after appropriate relabeling.Roslan, ABC Company production manager has suggested that the company could make better use of the welding machine by manufacturing premium mountain bike frames, which would require only 0.2 hours of welding time per frame. Roslan believes that ABC Company could sell up to 3,500 mountain bike frames per year to mountain bike manufacturers at a price of $65 per frame. The accounting department has provided the following data concerning the proposed new product:The mountain bike frames could be produced with existing equipment and personnel. Manufacturing overhead is allocated to products on the basis of direct labor-hours. Most of the manufacturing overhead consists of fixed common costs such as rent on the factory building, but some of it is variable. The variable manufacturing overhead has been estimated at $1.05 per drum and $0.60 per mountain bike frame. The variable manufacturing overhead cost would not be incurred on drums acquired from the outside supplier. Selling and administrative expenses are allocated to products on the basis of revenues. Almost all of the selling and administrative expenses are fixed common costs, but it has been estimated that variable selling and administrative expenses amount to $0.85 per drum and would be $0.40 per mountain bike frame. The variable selling and administrative expenses of $0.85 per drum would be incurred when drums acquired from the outside supplier are sold to the company’s customers.All of the company’s employees—direct and indirect—are paid for full 40-hour workweeks and the company has a policy of laying off workers only in major recessions.Required:1. Given the margins of the two products as indicated in the reports submitted by the accountingdepartment, does it make any sense to even consider producing the mountain bike frames?Explain.2. Compute the contribution margin per unit for:a. Purchased drums.b. Manufactured drums.c. Manufactured mountain bike frames.3. Determine the number of drums (if any) that should be purchased and the number of drumsand/or mountain bike frames (if any) that should be manufactured. What is the improvementin net income that would result from this plan over current operations?As soon as your analysis was shown to the top management team at ABC Company, several managers got into an argument concerning how direct labor costs should be treated when making this decision. One manager argued that direct labor is always treated as a variable cost in textbooks and in practice and has always been considered a variable cost at ABC Company. After all, ?direct? means you can directly trace the cost to products. If direct labor is not a variable cost, what is? Another manager argued just as strenuously that direct labor should be considered a fixed cost at ABC Company. No one had been laid off in over a decade, and for all practical purposes, everyone at the plant is on a monthly salary. Everyone classified as direct labor works a regular 40-hour workweek and overtime has not been necessary since the company adopted Lean Production techniques. Whether the welding machine is used to make drums or frames, the total payroll would be exactly the same. There is enough slack, in the form of idle time, to accommodate any increase in total direct labor time that the mountain bike frames would require.4. Redo requirements (2) and (3) above, making the opposite assumption about direct labor from the one you originally made. In other words, if you treated direct labor as a variablecost, redo the analysis treating it as a fixed cost. If you treated direct labor as a fixed cost, redo the analysis treating it as a variable cost.5. What do you think is the correct way to treat direct labor in this situation—as a variable costor as a fixed cost? Explain.

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